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Context: A recent report by a parliamentary committee has suggested that the government should change the Income Tax Act to make ESOPs (Employee Stock Option Plans) more favourable for startups and their employees.

Details

• The Department-related Parliamentary Standing Committee on Commerce has proposed that ESOPs should be taxed only when the employees sell their shares and not on unrealized gains.
• The report stated that ESOPs are an important tool for startups to hire talented people at lower salaries and to save cash for investing in their businesses.
• It highlighted the challenges faced by startups in India, such as lack of funding, regulatory hurdles, intellectual property rights issues, and competition from foreign players.
• It recommended that the government should create a conducive environment for startups to thrive and contribute to the economic growth and innovation of the country.

Highlights of the parliamentary panel Report

• The key recommendation from the parliamentary panel is to change the tax treatment of ESOPs. Currently, in many jurisdictions, including India, ESOPs are often subject to taxation at the time of exercise (when the employee buys the shares) based on the difference between the market value and the exercise price of the shares.
  • This means that employees have to pay taxes even before they sell the shares and realize any actual gains. This can be burdensome, especially for employees of startups who might not have the immediate funds to cover the tax liability.
• The recommendation suggests that ESOPs should only be taxed at the time the employee sells the shares, as opposed to being taxed on notional gains (the difference between the exercise price and market value) at the time of exercise. This change would provide employees with greater flexibility and reduce the financial burden associated with early-stage taxation of ESOPs. It could also help startups attract and retain talent by offering ESOPs as an attractive compensation tool.

While this recommendation can be beneficial for startups and employees, it also has implications for tax revenue collection and government fiscal planning. The government would need to carefully consider the potential impact on tax revenues and the overall economy before implementing such changes.

Employee Stock Option Plan (ESOP)

• Employee Stock Option Plan (ESOP) grants employees the right to buy company shares at a predetermined price. It serves as a tool for companies to attract, retain, and reward employees while aligning their interests with the company's growth and success.
• Eligible employees are given the right to purchase company shares at a fixed price known as the "exercise price" or "strike price." This price is often set at a discount to the current market value of the shares. However, employees must wait for a "vesting period" before they can exercise their right to buy the specified number of shares.
• Regulations for Issuance: ESOPs must adhere to specific regulations based on the company's status. Non-listed companies must comply with the Companies Act, 2013 and Companies (Share Capital and Debentures) Rules, 2014. For listed companies, the Securities and Exchange Board of India (SEBI) Employee Stock Option Scheme Guidelines apply.
• Eligibility for Recipients: ESOPs can be issued to various categories of employees and directors, including permanent employees within and outside India, directors (excluding independent directors), and employees/directors of a subsidiary, holding, or associate companies.
• Restrictions on Recipients: ESOPs cannot be granted to employees belonging to the promoter group or those who are promoters of the company. Directors who hold more than 10% of the outstanding equity shares, directly or indirectly, are also ineligible. However, these restrictions do not apply to startup companies for the first ten years after incorporation.
• Startup Exception: Startups are exempt from the restrictions on promoter-related employees and directors holding more than 10% equity shares for the initial ten years from their date of incorporation, allowing them more flexibility in granting ESOPs.

Conclusion

• An Employee Stock Option Plan (ESOP) is a compensation strategy that allows employees to purchase company shares at a predetermined price, aligning their interests with the company's success. While ESOPs offer potential financial benefits, they also come with complexities and considerations that employees need to be aware of when participating in such programs.

Must Read Articles:

PARLIAMENTARY COMMITTEES: https://www.iasgyan.in/daily-current-affairs/parliamentary-committees-33

https://www.tribuneindia.com/news/business/startups-mpspanel-for-making-esops-non-taxable-till-sold-534055

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